Don't panic!

When equities sold off on euro-contagion fears and on the news from Korea on Tuesday after failing at key resistance levels, is it time to panic?


My inner trader continues to believe that the Fed wants to throw a party. So let's have some fun, maintain trailing stops and don't worry. The one caveat to this outlook is - we should party as long as China doesn't slow down into a hard landing.


All eyes on China
Gluskin Sheff chief economist David Rosenberg agrees with my risk assessment. He wrote on November 22, 2010:

So long as China does not overdo it on its tightening moves — raising reserve requirements is indeed preferable to interest rate hikes — then commodity prices in general should remain on an uptrend even if a corrective phase should be expected after the QE2-related surge of the past few months. There is enough evidence supporting the notion that the Asian economy has decoupled from the U.S. consumer, and therefore, basic materials should still be a core holding in any given investment portfolio.

How much will China slow? Bloomberg recently reported that, according to their sources:

China’s biggest banks are poised to hit government-set caps on lending and plan to stop expanding their loan books to avoid exceeding the annual quotas.

With news like that, we will no doubt see a China growth scare in the weeks to come. The key to the market’s outlook is the Chinese plans for next year. Will they continue to tighten? Or with growth slowing, which heightens the risk of economic pressures and unrest from rising unemployment, will the Chinese authorities step on the accelerator again?

I believe that the latest round of quantitative easing by the Federal Reserve will have the effect of exporting asset price inflation to China, whose effects are unavoidable as long as China maintains a managed USD-RMB peg. Any administrative effects such as restricting bank loans or raising reserve requirements are therefore likely to have minor effects on the Chinese economy.


Does the US avoid a double-dip?
As Americans sit down to Thanksgiving dinner, it appears that the US may have avoided a double-dip recession. The 3Q GDP print at 2.5% was ahead of the consensus of 2.4% seems to be one sign that the economy is more robust than the bears believe.

I have also been monitoring the relative performance of the Morgan Stanley Cyclical Index (CYC), which is shown below. The CYC appears to be forming a bullish ascending triangle relative to the market. While the formation isn't complete until we see an upside breakout, these are not signs of a market that is likely to show significant weakness beyond the normal 5-10% corrections that may occur from time to time.

On the bearish side, the market remains overbought and sentiment is at or very close to crowded long territory, which is contrarian bearish. These factors suggest that equities are vulnerable to minor corrections but should be bought on weakness.